SECURITIES & EXCHANGE COMMISSION OF PAKISTAN
NIC Building, Jinnah Avenue, Blue Area, Islamabad
******
BEFORE APPELLATE BENCH NO. III
In the matter of
Revision No. 38 of 2003
Muhammad Maqsood F.C.A
3rd Floor, 39 Sadiq Plaza
Shahrah-e-Quaid-i-Azam
Lahore ………..…………………………………….………………….…Petitioner
Versus
Executive Director (EMD) SEC ……..……………………………………Respondent
Date of Impugned Order
June 30, 2003
Date of Hearing
December 22, 2003
Present:
For the Petitioner
Mr. Muhammad Maqsood. F.C.A
For the Respondent
1.
2.
Mr. Ashfaq Khan (Director) EMD
Ms. Wajiha Farooqi (Assistant Director) EMD
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Appellate Bench No. III
Appeal No.38/2003
Page 1 of 10
ORDER
This order will dispose off the revision petition No.38 of 2003 filed under
section 477 of the Companies Ordinance, 1984 by Mr. Muhammad Maqsood,
FCA against the order dated June 30, 2003 (the “Impugned Order”) passed by
the Executive Director (Enforcement & Monitoring).
1.
Brief facts leading to this revision petition are that the Executive Director
(EMD) imposed a fine of Rs.4,000 on Mr. Muhammad Maqsood FCA under subsection (1) of section 260 of the Companies Ordinance, 1984 (the “Ordinance”)
for not complying with the provisions of Section 255 of the Ordinance while
making out Audit report to the members of Taj Textile Mills Limited (the
“Company”) on the Financial statements of the Company for the years ended
September 30, 1998 and 1999. The auditors failed to report, among other
matters, that the company did not disclose assumption/adoption of short-term
borrowings of Rs.246.85 million relating to its associated unlisted company,
Elahi Enterprises, as required by 4th Schedule to the Ordinance and applicable
International accounting standards. The Executive Director (EMD) held that
the Petitioner had not conducted the audit in accordance with the applicable
auditing standards and his statements and representations in the audit reports
for the years ended September 30, 1998 and 1999 were false and misleading.
Aggrieved by the Impugned Order, Mr. Muhammad Maqsood has preferred this
revision petition, which was initially fixed for hearing on October 22, 2003.
However no one appeared before the Bench on the said date. The Bench refixed the case for December 22, 2003 to give the Petitioner another opportunity
of hearing. The case was finally heard on December 22, 2003, when Mr.
Maqsood himself appeared before us.
2.
Mr. Maqsood contended that the Impugned Order was against the law
and facts of the case and should be set aside. He argued that analogy of one
case cannot be extended in another penal proceeding as the Executive Director
has done in the Impugned Order. He stated that the audit conducted by Mr.
Suleman Zahid FCA, to which the Executive Director (EMD) has referred to in
his Impugned Order had nothing to do with him as it related to year ended
2001. He contended that the observations in respect of audit sampling made in
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Appellate Bench No. III
Appeal No.38/2003
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the Impugned Order were wrong and misleading as audit sampling is not
prohibited under the law. He stated that the making of disclosure as to the
existence and identification of related party was the duty of the management of
the Company and if the management for any reason fails or declines to
disclose, then the auditor cannot be held liable. He stated that the alleged
agreement between the Company and the related party was never brought to
his notice. He argued that in light of these facts it was clear that the default
was not committed knowingly or willingly and at best could be regarded as an
omission.
3.
Mr. Ashfaq Ahmed, Director (EMD) appearing on behalf of the Executive
Director (EMD) stated that the Petitioner was the engagement partner and
signatory of the audit reports for the years ended September 30, 1998 & 1999.
M/s Zahid Jamil & Co., Chartered Accountants of which the Appellant was a
partner had been the auditors of the Company since its incorporation on
March 24, 1986. They were also the auditors of one of the associated
undertakings of Elahi Enterprises (Private) Limited. The annual Financial
statements of the Company for the year ended September 30, 2001 revealed
that short-term borrowings of Rs.246.853 million had been transferred to the
Company from Elahi Enterprises. The aforesaid Financial statements did not
provide any further information in respect of the transfer of huge amounts of
loans from Elahi Enterprises. He stated that the Company had sustained
losses of Rs.210.887 million during the year ended September 30, 2001 and its
financial charges escalated by 166% in the second half of the aforesaid year
and unsecured local trade debts increased by 280% over the last year. He
stated that the audit reports for years ended September 30, 1998 & 1999 were
signed by Mr. Maqsood FCA, which is an admitted fact. He further contended
that a single show cause notice was issued in the matter to all partners of the
Audit firm for same default relating to 4 years from 1998 to 2000, however due
to the fact that the matter relating to Mr. Maqsood was delayed as he had
requested for more time from the Executive Director (EMD), a separate order
was issued in case of Mr. Maqsood. He stated that it was therefore wrong for
Mr. Maqsood to argue that his case was separate from Mr. Suleman Zahid and
an analogy to that order could not be made by the Executive Director (EMD).
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Appellate Bench No. III
Appeal No.38/2003
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4.
On the issue of audit sampling, Mr. Ashfaq stated that the Petitioner has
not given a single evidence of the steps he took to identify the related party’s
transactions and their treatment in the Financial statements. The Petitioner
did not provide to the Commission its working papers required to see why the
Petitioner failed to notice such a material transaction and what were those so
called sampling techniques employed during the audit. He contended that
ignoring such a transaction of so material significance cannot be termed
inadvertent negligence and was therefore intentional. He stated that it was not
clear how such an erroneous and allegedly negligent mistake could happen
continuously for number of years. He referred to ISA 550 which specifies many
steps that an auditor should perform before reaching on a conclusion.
5.
We have heard both the parties and considered their arguments. As the
Petitioner in his appeal has taken the plea that analogy of one case cannot be
extended to another in penal proceedings, we have carried out a detailed review
of the Financial statements and related audit reports for 4 years from 1998 to
2001 and records of proceedings by enforcement division for a judicious
disposal of the case. The Enforcement Division of the Commission while
examining the accounts of Taj Textile for the year ended 30.9.2001 noticed that
company had recorded Short term borrowings of Rs.246.853 million as its
liability (Note 7 to the Financial statements) and correspondingly increased its
“Un-secured local Trade debts” by the similar amount (Note 16 to the Financial
statements). Note 7.3 to Financial statements stated that, “Short term bank
borrowings also include bank credit facilities amounting to Rs. 246.853 million
conveyed from Elahi Enterprises (pvt) Limited” No further information was
available in the said financial statements in this respect. The auditors issued
an Unqualified Audit report on these Financial statements and audit report did
not state specifically anything in relation to above.
6.
On further examination of the Financial statements of Taj Textile, it was
noticed that the company has suffered from a substantial loss of Rs.210.877
million during the year ended 30.9.2001 as compared to an after-tax profit of
Rs.17.698 million last year despite the fact that its peers have made handsome
profits during the year. Further, the financial charges of the company which
averaged around Rs.135 million per annum for the last several years and stood
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Appellate Bench No. III
Appeal No.38/2003
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at Rs.158.587 million in the year 2000, escalated to Rs.245.775 million in the
year 2001. Furthermore, a comparison of half yearly accounts for the period
ended 31.3.2001 with the annual accounts for the year ended 30.9.2001,
revealed that the company incurred financial charges of only Rs.67.206 million
for the first six months of the year whereas financial charges of Rs.178.568
million were booked for the last six months of the year indicating an increase of
166%. Similarly, there was an abnormal increase on account of un-secured
local trade debts which rose substantially from Rs.68.883 million as on
30.9.2000 to Rs.262.040 million as on 30.9.2001. Translated as percentage,
the increase in unsecured local trade debts amounted to 280% during the year
2001. The Enforcement division took up the issue with the company and its
auditors to explain the reason for not reporting the assumption of loans by the
company which actually belonged to Elahi enterprises.
7.
The information, explanation and records provided by the company and
its auditors further revealed the following:(i)
M/s. Elahi Enterprises is an associated undertaking of Taj Textile
as evident from composition of Board of Directors Of both
companies consisting of common directors.
(ii)
The loans of Rs.246.853 million payable by Elahi Enterprises to its
various bankers were assumed by Taj Textile during the years
1998 to 2001. This assumption of liabilities of Elahi enterprises by
Taj Textiles was reportedly made under the pressure of the
bankers of Elahi Enterprises who felt un-secured because of
absence of significant asset base of Elahi Enterprises, which is
evident from the minutes of the board of directors’ meeting of Elahi
Enterprises Ltd dated April 20, 1998, June 26, 1999, October 18,
1999, February 3, 2000 and January 2, 2001 and board of
directors of Taj Textile Mills Ltd dated February 23, 1998.
(iii)
The aforesaid loans taken by Elahi Enterprises from the financial
institutions were secured by personal guarantees of its directors,
who were also directors of Taj Textile.
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Appellate Bench No. III
Appeal No.38/2003
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(iv)
Loan obligations were transferred through an agreement executed
on April 22, 1998 between Taj Textile and Elahi Enterprises for the
transfer of loans of Rs.246.853 million and payment of financial
charges thereon by Taj Textile. On the basis of this agreement,
transactions were recorded in the books of accounts of Taj Textile
wherein loans payable to financial institutions of Elahi Enterprises
were treated as liability of the company and corresponding asset
account was created as receivable from Elahi Enterprises.
(v)
M/s. Taj Textile has been bearing financial charges on the loans
unfairly transferred from Elahi Enterprises since 1998 and
according to the Chief Financial Officer of Taj Textile; financial
charges of Rs.53.086 million have been paid by Taj Textile since
1998 in regard to loans transferred from Elahi Enterprises.
(vi)
The company did not disclose the transactions and related asset
and liabilities in its Financial statements for 3 years from 1998 to
2000. The asset receivable account and Short term loan obligations
account
created
in
General
ledger
of
the
company
as
a
consequence of above transaction were closed at the closure of
each financial year from 1998 to 2000 through offsetting these
accounts by passing contra entries.
(vii)
The auditor gave the company an unqualified report with out
giving any reference to the above transactions.
(viii) Despite repeated requests by the enforcement division, none of the
auditors of Taj Textile provided any working papers to demonstrate
procedures undertaken by them to conduct of audits of Taj textiles
for these years.
8.
Executive Director (EMD) proceeded under section 476 of the ordinance
and held auditors in default in complying with the provisions of sections 255
and 260(1) of the Ordinance through his orders dated April 29, 2003 and June
30, 2003 against Mr. Salman Zahid, FCA and Mr. Mohammad Maqsood
respectively. A fine of Rs 4000 each was imposed on Mr. Salman Zahid and Mr.
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Appellate Bench No. III
Appeal No.38/2003
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Mohammad Maqsood for 2 years each for making out reports on Financial
statements of the company other wise than in conformity with the Ordinance,
making out untrue and false statements, and failure to bring material facts
about affairs of the company. Mr. Salman Zahid appealed before the appellate
bench against Executive Director’s (EMD) Order dated April 29, 2003 which
was rejected by the appellate bench and the said order was up held.
9.
What we infer from our detailed review of information available on record
and after hearing the arguments of the Petitioner and Enforcement division’s
representatives is that in 1998 M/s Taj textiles assumed the liabilities of its
associated company Elahi enterprises unfairly and against the business
interest of the company and concealed this transaction completely for 3 years
from 1998 to 2000. The information was first reported and a limited inadequate
disclosure was given in the Financial statements for the year ended September,
2001. Auditors during all these years, from 1998 to 2001 did not give any
reference to this issue in their Auditor’s report. The core issue to determine for
disposing off this Revision petition judiciously is the Auditor’s Scope, objective
and professional responsibilities in relation to performing an audit of the
Financial statements and his conclusion thereupon.
Section 255 of the
Ordinance, Auditors report (form 35-A) and International standards on
Auditing as adopted by the Institute if Chartered Accountants of Pakistan
govern the objective, scope, conduct and procedures to be applied essentially,
and level of assurance required from the auditor on the truth and fairness or
otherwise of the Financial statements. Section 255 of the Ordinance requires
company’s statutory auditor to make a report giving his opinion based on his
thorough review and examination of the records, explanation and information
of the company, among other matters, whether proper books of accounts as
required by the Ordinance have been kept, whether Financial statements have
been drawn up in conformity with the Ordinance and in agreement with books
of accounts and whether Financial statements give true and fair view on the
company’s profitability and its state of affairs. Auditing standard-1 “Objective
and General principles governing an Audit of Financial statements” which
governs all other auditing standards provides, “the objective of an audit of
Financial statements is to enable the auditor to express an opinion whether the
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Appellate Bench No. III
Appeal No.38/2003
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financial statements are prepared, in all material respects, in accordance with an
identified financial reporting framework. The phrases used to express the
auditor’s opinion are “give true and fair view””. This standard requires the
auditor to plan and perform an audit with an attitude of professional
skepticism recognizing that circumstances may exist that cause the Financial
statements to be materially misstated. This standard also requires auditor to
apply professional competence and due care while performing his audit as part
of his professional responsibilities. The above governing legislation and
standards imply that the statutory auditor of a listed company has legal
obligation to ensure to his satisfaction that Financial statements of the
company exhibit true and fair view on company’s profitability and its state of
affairs and that company’s books of account have been kept as required by law.
International standards on Auditing, then, provide the frame work and
procedures to be adopted to achieve this objective by gathering sufficient
appropriate
evidence
enabling
him
to
support
his
audit
conclusion.
Considering the materiality and related financial impact of the transactions
under question, it is hard to believe that the auditor could not identify the
transactions under question in spite of applying necessary procedures to
obtain sufficient appropriate evidence to reach his Audit conclusion. It is an
admitted fact that the transactions in question were appearing in the ledgers of
the company, were discussed in detail in board of directors minutes and even
resultant financial charges had been booked by the company on assumption of
liabilities of Elahi Enterprises. Had the auditor applied basic audit and
analytical procedures, reviewed minutes of board of directors’ meetings and
had questioned the rising trend in financial charges, the facts would have come
to light. It appears that either auditor did not bother to perform basic tests
involved in audit or they were party to the whole scheme for unethical and
unfair transfer of associated company’s liabilities to the company. The auditor
failed to perform his duties with reasonable care , professional skill and
caution. The courts have internationally held in various cases that Auditor has
a duty to conduct his audit with skeptic attitude, reasonable care and caution.
Lord Lopes L J held in Re Kingston Cotton Mill that , “ It is the duty of an
auditor to bring to bear on the work he has to perform that skill, care and
caution which a reasonably competent, careful and cautious auditor would
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use.” Lord Denning in the case of Fomento(Sterling Area)Ltd v Selsdon Fountain
Pen Co Ltd 1958 defined the auditor’s proper approach to their work by saying,
“they must come to it with an inquiring mind-not suspicious of dishonesty –but
suspecting that someone may have made a mistake and that a check must be
,made to ensure that there has been none.” But, in the instant case, the
auditor did not provide any evidence to prove that he applied all necessary
procedure to ensure that financial statements were free from any material
error.
10.
As for ground no. 3 taken by the petitioner that he had honestly applied
the tests prescribed by Auditing standard 19-Audit sampling and Other
selective Testing procedures, we reviewed ISA 19 which stipulates in its very
beginning in Para 2. , “ When designing audit procedures, the auditor should
determine appropriate means for selecting items for testing so as to gather
audit evidence to meet the objective of audit tests”. This means that the
purpose of audit sampling is to gather audit evidence to meet the objectives of
audit tests. Now looking at the purpose of audit evidence, we reviewed Auditing
standard 8- Audit evidence which requires in its Para 2, “The auditor should
obtain sufficient appropriate evidence to be able to draw reasonable
conclusions on which to base the audit opinion”. and Auditing standards-1Objective and General principles governing an Audit of Financial statements
which governs all other auditing standards provides, “the objective of an audit
of Financial statements is to enable the auditor to express an opinion whether
the financial statements are prepared, in all material respects, in accordance
with an identified financial reporting framework. The phrases used to express
the auditor’s opinion are “give true and fair view”. By reading the above
reference of Auditing standards together, we infer that the International
standards on Auditing require auditor to plan and execute his audit using
procedures which provide him sufficient appropriate evidence to reach his
audit
conclusion as to the trueness and fairness or otherwise of Financial
statements under review.
11.
As for petitioner last ground relating to his inability to identify related
parties and related party transaction when management did not disclose the
same. We are unable to comprehend as to how auditor would have omitted
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identification of transactions of such nature, magnitude and grave financial
impact. The auditor just needed to review the minutes of Board of Directors
and he would have identified the whole scheme of these transactions and
issues involved. Further, the fact that the same audit firm is also the auditor of
Elahi enterprises makes it impossible for the auditor not to identify the related
party relationship between the two companies who had common directors on
their Board of Directors.
12.
This is a classic case of hiding transactions by the company with its
associated company by not reporting the same in its Financial statements over
several years. The transaction had no basis – Assumption of huge liabilities
with no corresponding tangible assets in exchange is like making complete
irony of business and accounting principles. The management of company
concealed the transactions from its shareholders by wrongly off-setting the
corresponding asset and liability accounts with the intent to defraud the
readers of Financial statements. And it is hard to believe considering the
nature, magnitude and financial impact of the transactions that the same
could be done without connivance of auditors. In our view, this case is strong
candidate for proceedings under subsection (2) of section 260 of the Ordinance.
E.D. (Enf) opted to proceed under section 260(1) holding auditor negligent in
performing his audits of the company which already is a fairly lenient
treatment of the defaults involved.
13.
In light of the submissions of the parties and the above findings, the
order of the Executive Director (Enforcement & Monitoring) dated June 30,
2003 is hereby upheld. This Revision is dismissed accordingly.
(ETRAT H. RIZVI)
Commissioner (SCD)
(M. ZAFAR UL HAQ HIJAZI)
Commissioner (PSP)
Announced in Islamabad on December 31, 2003
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